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Nayan Patel

Sep 13, 2023

unlisted Trust distribution

in SMSF Technical Forum

I am auditg fund that is holding 100% units in realted Trust. The trust sold investstment property held, during the year with capital gainof 600K. The trust ITR provided for audit reflect 600k distribution to smsf as capital gain along with the capital gain schedule with para 8 other CGT information that describe small business 15 year exemption -exempt capital gain.

The fund opertaing statement reflects this distribution as other income Capital gain exempt- however this income is not reflected in the tax return of the fund as it is considered non taxable income.

I never have come accross such sitution-

1 comment

Comments (1)

The Auditors Institute Ltd

Sep 14, 2023

Hello Nayan

As you suggest, this is a most unusual situation.

Whilst as a general proposition fund auditors do not have to recalculate a fund's income tax expense to see if it matches to the last cent to the fund’s calculation, it is still expected that a fund auditor is comfortable that the income tax expense has not been materially misstated.

In the situation raised in this question, it is assumed that if the 15-year exemption under the small business concessions is not available to the unit trust, that the fund (if 100% in accumulation phase) has a potential net capital gain of $400K (taking the $600K, assumed to be a gross amount, and applying the 1/3rd discount). The potential tax liability is assumed to be $60,000 ($400,000 x 15%). I'll assume this is a material amount.

Given that the unit trust is 100% owned by the fund, it is clearly a related party unit trust. Assuming it is not a pre-11 August 1999 unit trust, as a related party unit trust, to be excluded from being an in-house asset, the unit trust needs to comply with the requirements in Regulations 13.22C and 13.22D of the SIS Regulations.

Amongst other things, one of the requirements in these regulations is that the unit trust is not carrying on a business.

Let's now consider the potential application of the small business concessions, starting with the basic conditions in subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997). All legislative references from hereon in are to the ITAA 1997 unless otherwise stated.

In particular, under subsection 152-10(1)(d) the CGT asset that was disposed of need to satisfy the active asset test (in section 152-35).

To satisfy the active asset test, the asset needs to be an "active asset", as per section 152-40.

Broadly, to be an active asset (of the unit trust that triggered the CGT event) the property needed to have been used in the course of carrying on a business of either:

· the unit trust;

· an "affiliate" of the unit trust; or

· or another entity that is "connected with" the unit trust.

"Affiliate" is defined in section 328-130 as follows:

328-130(1) An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the *business of the individual or company.

328-130(2) However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

It is assumed that the unit trust was not carrying on a business in its own right in relation to the property (referred to as an "investment property" in the question).

We can see from the above definition that an entity is only capable of being an affiliate if it is an individual or a company. Moreover, even if the tenant that rented the unit trust's investment property happened to be an individual or a company, it would be most unlikely that the tenant acts in accordance with the directions or wishes of the trustee of the unit trust (in its capacity as trustee of the unit trust) in relation to the affairs of the business of the tenant! If for some strange reason this could be satisified, it is likely to indicate other substantial SIS Act compliance issues.

As the super fund owns all the units in the unit trust, the super fund is considered to be "connected with" the unit trust as per section 328-125. However, the very nature of a superannuation fund, is that it is not capable of being connected with its fund members (even if the fund members are considered to be connected with entity that was the tenant). Accordingly, the investment property cannot be said to have been used in the business of an entity that is connected with the unit trust.

The ATO concluded in TD 2006/68 the members of a complying superannuation fund, are not capable of being "connected with" the fund.

[ATO link to TD 2006/68]

https://www.ato.gov.au/law/view/document?locid=txd/td200668/nat/ato

Hypothetically, if the super fund owned 60% of units and a member of the fund personally owned 40% of the units, and the member of the fund as a sole trader leased the business premises from the unit trust, it could be possible to show that the member of the fund is connected with the unit trust and the investment property could be an active asset.

However, this hypothetical does not appear to be relevant to the scenario at hand given the question states the "fund that is holding 100% of the units".

Given the facts as stated in this question, I cannot see how the passive investment property disposed of by a unit trust 100% owned by a self-managed fund can satisfy the basic conditions in subdivision 152-A to access the CGT small business concessions.

Given the above, it would be suggested that there is discussion with the fund’s accountant to reconsider the application of the small business concessions in this scenario.

Thanks for the question.